ATO Interpretative Decision

ATO ID 2003/526

Income Tax

• This document incorporates revisions made since original publication. View its history and amending notices, if applicable.

Issue

Is a lump sum amount received by the taxpayer, for granting a life time right to reside in their investment property, ordinary income for the purposes of section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) where the tenant has a right to a pro rata refund if they leave the property?

Decision

Yes. A lump sum amount received by the taxpayer, for granting a life time right for a relative to reside in their investment property, is ordinary income for the purposes of section 6-5 of the ITAA 1997 where the tenant has a right to a pro rata refund if they leave the property.

Facts

The taxpayer owns an investment property.

The taxpayer's relative wished to rent the property.

The relative has made a lump sum payment in exchange for a life time right to reside in the property.

The relative or their estate will be entitled to receive a pro-rata refund of any unexpired portion of the lump sum payment on vacating the property. The refund will be determined by calculating the period of occupancy multiplied by the market value of the weekly rent and subtracted from their lump sum.

Reasons for Decision

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Ordinary income is defined as income according to ordinary concepts (subsection 6-5(1) of the ITAA 1997). Factors like periodicity, recurrence, regularity or services performed have been identified by the courts as indicating that an amount is income according to ordinary concepts. However an amount received in a lump sum can also be ordinary income depending on the nature of the lump sum payment.

If the purpose of the lump sum payment is to provide a substitute for an income stream then that lump sum may take on the character of those payments it is intended to replace.

In the circumstances here the issue is whether this lump sum was intended to replace future rental income and whether it amounted to a lump sum payment of prepaid rent.

We can take some guidance on this issue from Taxation Ruling TR 2002/14 which deals with the characterisation of receipts on the granting of occupancy rights in the context of retirement villages. Although this ruling applies to the taxation of retirement village operators the principles discussed in determining whether an amount is pre paid rent are relevant here.

Paragraph 129 of TR 2002/14 summarises the circumstances where a lump sum should be accounted for as prepaid rent as being where:

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a person is prepared to make a lump sum payment in exchange for the right to occupy a dwelling for a fixed term

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the person is entitled to receive a pro-rata refund for the unexpired portion of the term (if any) and

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the intention of the parties is that the lump sum payment in advance is for the use and enjoyment the dwelling for the fixed term.

In the circumstances here the taxpayer has received a lump sum payment in exchange for the use and occupation of the rental property by the relative.

The taxpayer will be required to refund any unexpired portion of the pre paid rent to the relative or the relative's estate. The amount of any refund is calculated by reference to the current market value of the rental during their occupation of the dwelling and subtracted from the lump sum payment.

The intention of the parties is that the lump sum payment in advance is for the relative's use and enjoyment of the property. The effect of the way the refund is calculated means that the tenant is effectively paying a weekly rental for the period of their occupancy. Therefore, the lump sum payment has the character of rent received in advance.

The rent received in advance is to be bought to account progressively. This is supported by paragraph 130 of TR 2002/14 which states that rent paid in advance to retirement village operators should be brought to account over the period for which the payment is made, in accordance with the principles laid down in Arthur Murray (NSW) Pty Ltd v. Federal Commissioner of Taxation (1965) 114 CLR 314; [1965] HCA 58; (1965) 14 ATD 98; (1965) 9 AITR 673. The principles arising out of Arthur Murray may be summarised as follows:

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subject to any special statutory provision, the inquiry to be made in each case is whether the receipt would, according to established accounting and commercial principles, be regarded as income derived, and

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as a matter of business good sense, the recipient should treat each amount of fees received but not yet earned as subject to the contingency that the whole or some part of it may have in effect to be paid back.

An annual rental income calculated on the applicable market rate is to be included in the taxpayer's assessable income under section 6-5 of ITAA 1997 for each succeeding financial year.

Amendment History

Year of income:  Year ended 30 June 2003

Legislative References:
Income Tax Assessment Act 1997
   section 6-5
   subsection 6-5(1)
   subsection 6-5(2)

Case References:
Arthur Murray (NSW) Pty Ltd v. Federal Commissioner of Taxation
   (1965) 114 CLR 314
   [1965] HCA 58
   (1965) 14 ATD 98
   (1965) 9 AITR 673

Related Public Rulings (including Determinations)
Taxation Ruling TR 2002/14

Siebel/TDMS Reference Number:  3451561; 1-7L6WYUM

Business Line:  Individuals

Date of publication:  4 July 2003

ISSN: 1445-2782